Loan Refinance

[Madison71]

Good Morning - 

A participant took out a loan from his 401(k) plan on January 1, 2018 with repayments over a 5 year period ending on December 31, 2022. Participant was a qualified individual under the CARES Act and requested a suspension of the loan back in June 2020.  The loan was reamortized in January 2021 which extended the original repayment end date out one year to December 31, 2023. Participant is wanting to take out another loan, but the plan only allows one outstanding loan at a time.  However, the plan does permit loan refinancing and the participant is now requesting to refinance the loan.  The participant is looking to take out an additional amount and refinance to December 31, 2023.  Is there an issue since the replacement loan is technically more than 5 years from the existing loan's origination date of January 1, 2018? 

[Luke Bailey]

Madison71, see Treas. Reg. 1.72(p)-1, Q&A-20(a). Generally, you can refinance, even if the plan only permits one loan to be outstanding at any time. However, the sum of the highest outstanding on the original loan, plus the amount (not just the net over the refinanced) cannot exceed the loan limit.

[Madison71]

Thanks Luke. What about the timing? Any concern with the refinanced loan essentially exceeding 5 years when looking at the origination date (due to the additional time granted due to the suspension under CARES)? 

[Pam Shoup]

If you look at I.R.B. 2002-51, Question 20 is a good example of how this is to be handled.  The new loan replaces the old loan and can for 5 years.  However, you have to take both the old loan AND the new loan amount into account at the same time when applying the limits.  

[BG5150]

AND, the original loan amount must be repaid by the end of 5 years from the original.

For example, old loan $5,000 over 5 years.

After 3 years, $3,500 balance left.

Refinance for additional $5,000 for 5 more years.  The amortization schedule must have the original $3,500 paid off within 2 years (or, by 5 years after original)

Or, at least that is how I understand the rules.

[Luke Bailey]

1 hour ago, BG5150 said:

Refinance for additional $5,000 for 5 more years.  The amortization schedule must have the original $3,500 paid off within 2 years (or, by 5 years after original)

Yes. So if you immediately pay off the old loan out of the proceeds of the money, which I think is how folks would typically do it, you should be good.

[Madison71]

Thank you all, but still confused.  I will need to revisit Treas. Reg. 1.72(p)-1, Q&A-20(a).  I thought if the original loan was already a 5 year loan that if the loan was being refinanced, then it had to remain within that 5 year period UNLESS the plan allowed for two loans.  There would essentially be two loans for a short period of time while the replacement loan was repaid.  I will revisit.  Thanks again - I appreciate it. 

 

[BG5150]

3 hours ago, Luke Bailey said:

Yes. So if you immediately pay off the old loan out of the proceeds of the money, which I think is how folks would typically do it, you should be good.

That's not how my interpretation on how refinancing plan loans works.

The first loan does not get repaid, but merely gets absorbed into the new, 'refinanced' loan.  That is how you get around the thorny two-loan problem.

If the plan only allows for one loan, you would not be able to take a second loan in order to pay off the first.  With refinancing, there are never two loans at the same time.

But, under the rules, the amount outstanding from that first loan must be paid off no later than 5 years after its origination.

 

[Madison71]

That is helpful!  Thank you!  I thought I saw mention on this board of there being actually two loans…if even for a very short period of time when you extend the replacement loan beyond the original terms of the replaced loans.  I’m sure I misinterpreted the point. That’s why I would rather have a plan allow for two loans or allow only one loan without refinancing to avoid the confusion.

Thanks again!

[Luke Bailey]

6 hours ago, BG5150 said:

That's not how my interpretation on how refinancing plan loans works.

The first loan does not get repaid, but merely gets absorbed into the new, 'refinanced' loan.  That is how you get around the thorny two-loan problem.

BG5150, see below for a different take.

1 hour ago, Madison71 said:

I thought I saw mention on this board of there being actually two loans…if even for a very short period of time when you extend the replacement loan beyond the original terms of the replaced loans.  

I think in substance there are two loans, but you can call them one. If the plan says (a) you can only have one loan, but (b) you can refinance, then I think the refinancing paperwork could, which would say "refinancing paperwork" (in effect) at the top of the document, or obviously could be electronic, would say the existing loan is being turned into a loan that will go out five years from the date of the refinance, and will be for an amount equal to the old loan plus some extra, but only the extra gets disbursed as new cash. As long as the new cash amount could have been done as a second loan, you should be OK. At least that's the way I read the reg.

[Madison71]

Thank you!  This helps a lot! 
 

I appreciate everyone’s time on this